Bank of Japan, New Policy Implications - The Reverb

The decision of the Bank of Japan last week to up the ante on asset purchases and to extend the maturity of purchases was a truly remarkable surprise to the financial markets. From many perspectives it could be considered an unprecedented monetary policy decision with deep repercussions to being felt around the world.

Market expectations before last week's announcement were set somewhere at about 2-4 trillion Yen additional asset purchases, as opposed to 7 trillion Yen as indicated by the BoJ Governor Haruhiko Kuroda, not to mention the surprisingly wider array of asset classes and maturities eligible under his new plan.

The goal of this plan, to defeat deflationary pressure in the Japanese economy, is unequivocally positive from a risk-taking investment point of view, at least in the near term. I am inclined to think that this plan is almost certainly a game-changer as far as a decline in the Yen, relative to other currencies, is concerned.

In fact, the scale of monetary easing involved is estimated to reach around 30% of Japan's GDP by the end of 2014 (incidentally, the FED balance sheet expansion is about 15% over a period of 5 years) and the pace of Yen depreciation should pick up steam fairly quickly towards the 100 Yen/$ mark.

Kuroda's program is aimed at turning around Japan's deflationary environment and raising expected inflation to 2%. Nonetheless, past experience tells us that a story of countless and arguably unsuccessful Quantitative Easing policies from the BoJ have done little to eradicate deflation. Hence I would argue that to successfully fight deflation, the Government needs to put forward, as per its intentions, a comprehensive set of supply side reforms aimed at improving its competitiveness, together with stronger long term fiscal control over its public finances.

On these two counts of course, it will be Prime Minister's Shinzo Abe's job to deliver, particularly on highly contentious matters, such as an increase in the sales tax, a greater resolve on to cut unproductive government expenditures and last but not least to push for more competition in an overregulated economy.

In the aftermath of this announcement from the Bank of Japan will this three-pronged approach bring to a Yen avalanche, as has been suggested by prominent investors such Bill Gross and George Soros? The implication would be that in their opinion what the BoJ started might actually slip out of control, considering that the BoJ seems the most aggressive central bank pushing the envelope on the adoption of experimental monetary measures using somewhat imperfect tools.

Although this is a legitimate concern, in my opinion the likelihood of that to happen is probably not very high for at least two main reasons:

1. The BoJ has not given any indication that there will be any purchase of foreign currencies against sale of Yen.
2. The fact that differently from the recent FED Quantitative Easing 3, this plan has no open-ended expiration date.

One might also argue that the most industrialized countries could try to put the brakes on Yen depreciation before the 2% inflation goal has been achieved. Regardless, from an investment perspective history tells us the Y/$ exchange rate has been hovering in a broad range around the 110-115 level for the most part of the decade before 2009.

Therefore I do not see a strong reason to believe that such an exchange level could be reached without much resistance, gradually offsetting what the US monetary policies of the last five years have achieved in terms of dollar appreciation versus the Yen. 

As a corollary to a continuing of a weak yen environment, I would also be inclined to maintain or start an overweight allocation to Japanese equities with particular emphasis on exporting companies.